COVID–19 Impact on business and financial reporting

The world was a well-oiled machine of commerce till about November last year. Offshore software services companies out of India served a majority of the enterprises across the world from Energy & Utilities, Retail, Travel & Hospitality, Banking & Financial Services. Apple Inc, NASDAQ Composite’s darling stock had complex supply chains across the world predominantly in China and Taiwan. There was still something about the laconic text behind every apple device – Designed by Apple in California, Assembled in China which attracted consumers across the world to its eco-systems of devices and services which made it the most profitable company in the world in the technology space. Apple’s trailing 10-year average revenue of 18% came from its second-biggest market China.

The supply chain of Apple is a case study that is taught in business schools on how intricately woven in the world’s supply chain. In a gist, Apple designs the circuitry that goes in its devices, outsources the manufacturing of this circuitry to foundries like TSMC(Taiwan Semiconductor Manufacturing Company, the world’s largest independent semiconductor manufacturing company) to manufacture the Integrated Chip(IC) on a large scale. TSMC then sends these ICs to another company Foxconn(Another Taiwanese company which has factories in China) for assembly into the final product. TSMC’s raw material like precious metals, semiconductor components comes from mining companies in Africa and other parts of Asia. In an intricate supply chain system with many players across geographies, such as Apple’s, regional lockdowns can have a profound impact on the whole system. President Donald J. Trump of the USA has openly stated on many occasions, his anti-immigration and anti-China beliefs. While Trump supporters would argue that he has tried to promote domestic manufacturing in some sectors and that he has raised tariffs on Chinese imports, it is evident that Trump hasn’t been able to achieve his stated goal. However, his stance on China has been considered detrimental to and obstructive of world trade, by many leading investors. To an extent, his policies had the effects he desired. In 2019, Chinese exports to the US had declined by about 11%. However, despite this decline in Chinese imports to the USA, there were no seismic shifts in commerce and world trade. The American trade war with China proved to be nothing more than media brouhaha.

Yet as I write this article in April 2020, something greater than ten in the Richter Scale has shaken the world economy. World over, people are getting infected by a COVID-19 virus which has symptoms similar to the common flu. But similar to the common flu, it has no vaccine. More than twenty lakh people(two million) around the world have been infected and around two lakh people have died. More are expected to be infected in the coming days and months. Because the Covid-19 virus spreads via human contact, we are now forced to avoid travel, going to cinemas, dining out, going out on vacations, and more importantly avoid going to work. Discretionary spending has almost seized and people are scared to venture out of their houses in fear of contracting the virus from someone else. Automobile manufacturers, airlines, hospitality chains, restaurants, shopping malls have shut manufacturing or their shops. To see how it has impacted the common man across the world, check out this statistic published in the Mint NewsPaper – In the past four weeks, seventeen million Americans have applied for unemployment benefits. Almost one million Britons applied for welfare payments in the space of two weeks, 10 times the normal amount. A record 470,000 companies applied for German state wage support in March. More than twenty-three million, or a third of Thailand’s population, have registered for the government’s cash handout since it was made available on 28 March^. The grants are intended to cover only nine million people. The second most populous country, the largest democracy in the world India has been locked down for the past 21 days and has extended the lockdown till May 3. This lockdown is the largest in human history and by far the longest. Every week of lockdown is wiping out INR 8 trillion from its GDP* (India’s GDP is roughly around INR 203 Trillion as of the end of 2019). These times are unprecedented since the second world war. Some Economists estimate that the impact will be worse than the great depression of 1929.

Well, nobody can predict the future and these are just estimates. All we can hope at this stage is that humanity will find a vaccine for the pandemic soon. Humanity will find its way through these difficult times as it has found before in recorded history. However, it is important to note that the post corona world will never be the same. Humans would have learned their lesson and paid a heavy cost for it (deaths, economic loss, job loss, etc) and wouldn’t want to repeat the same mistakes again. So what would the post corona world look like? First and foremost there will be a seismic shift in behavioral traits of humans – We will shun public spaces, avoid social gatherings, work from home more often, conserve cash, avoid travel unless absolutely necessary and take selfies with masks on. This article will examine some of the impacts these news traits will have on the functioning of the companies. The article will also shed light on some of the accounting standards that accountants should consider in a post-covid-19 world.

India’s economy even before the advent of the pandemic was reeling under pressure due to supply and demand issues. India’s GDP growth slowed to 4.5% y-o-y in Dec-19 compared to the 7% levels it had seen in FY 18 and FY 19. The pandemic has exacerbated the problem exponentially. As the lockdown gradually is lifted from May 2020 onwards, businesses will start limping and crawling to normalcy. However many businesses will shut shop due to either lack of demand or their inability to service their debts. Take for example an amusement park, even though the lockdown restrictions have been lifted and the country is able to flatten the curve, people will be hesitant to go to these parks because of fear of catching an infection. This would mean for the amusement park lesser footfalls and eventually lesser revenue. Every business soon has to invoke the fundamental accounting assumption called going concern. It has to on its reporting end date ascertain its ability to continue as a going concern in the foreseeable future (IFRS says at least for the next year – IAS 1). I had studied going concern assumption when I was preparing for my accounting qualification and it never assumed so much significance so far in my professional experience. In these adverse times, accountants in every organization will spend considerable time understanding the ability of the business to continue as a going concern – Will the business continue to be able to service the debts in the coming periods? Do I have clear visibility on the revenue forecasts in the coming periods? Will my business continue to be profitable in the near future and what are the levers available to drive profitability? These are some of the questions the business owners, CFOs, and Accountants have to answer.

In the post corona world, businesses also have to retune their revenue models. Take for example restaurants. Stewardess at the restaurant entrance guiding us to the comfy table with a live band performing jazz might be a thing of the past. As people shun public spaces, they would prefer to take away or order from home through food aggregator apps. These models existed even before the outbreak however they will be a major chunk of the revenues going forward. Expanding the business through additional restaurant chains might not make much sense rather investments might be directed towards cloud kitchens which are integrated with the food delivery platforms. As a result, restaurants will optimize their fixed costs through – canceling some of their leases, or renegotiating the terms of the lease (IAS – 17 Leases) or even selling some of their commercial properties. So the accountants and finance executives should ask themselves – Is there a change in the way I recognize and report revenue? What should be the revenue sharing model with the food delivery platform?

Services business, on the other hand, should look at their contracts with customers. Take the case of Airlines, for example, I had an upcoming trip in May 2020 and the airlines sent me an email to cancel the ticket without cancellation fee or take a credit voucher for the ticket fare which can be used within one year. The former is a cash losing proposition and the latter is a cash saving proposition for the business. Ergo accountants should review if their revenue accounting policies are in line with IAS 15 Revenues from contracts with customers

In the automobile space, automobile manufacturers depend on auto-ancillary part manufacturers to supply them with the essential parts that go into their assembly lines. These auto-ancillary part manufacturers who are typically MSME(Micro, Small and Medium Enterprises) are staring at an inevitable scenario of shutting down because the demand for automobiles has come down drastically. These MSMEs still have to pay their workers, pay the leases for their factory. As a result, their situation is precarious. Post COVID-19, their ability to continue as a going concern would be put to test. The automobile manufacturers on their part might choose to help these suppliers by giving leeway in-terms of advance payments or lessening their credit period with their vendors so that the working capital needs of the MSME can be taken care of. Ergo vendor agreements should be relooked at to ensure business continuity with minimal disruptions. It is interesting to see how the automobile space evolves after the COVID-19 is kicked out of the world. I think the demand should be back as people would prefer to use their own transport and avoid public transport or uber/ola or carpool in fear of catching an infection.

I often read these days in newspapers that many industries are seeking support from the government to support them during the lockdown and post lockdown. Some of their concerns are genuine, their businesses are shut for more than a month and their revenues might continue to be squeezed even after the lockdowns are lifted. The government might help them get their feet back on track by various policies – Moratorium period on their outstanding loans, one time grants, tax holidays, etc.., As more and more businesses across industries in the coming days opt for government assistance, they would have to record and report it based on the standards mentioned in IAS 20 on Accounting for Government Grants and Disclosure of Government Assistance or IAS 12 on Income taxes.

When China was at the peak of the outbreak in February of this year, China National Offshore Oil Corporation (CNOOC) a Chinese state-run oil company invoked Force Majeure(FM) clause in the contract with Royal Dutch Shell to refuse a shipment of liquefied natural gas*. The FM clause is penned in many contracts as a recourse to the liability of the party to the contract in acts of god situations, like hurricanes and earthquakes. This should be changed to- Whether the Coronavirus outbreak, would be considered a Force Majeure event, is dependent on international court rulings. Irrespective of that, China has seen most of its companies invoke this clause to avoid performance as per the contract. In the coming days, India Inc will face tremendous pressure fulfilling the terms in their contract. As a result, enterprises should anticipate losses on account of supply chain disruptions or losses due to the overall decline in economic output properly in their financial statements. IAS 37 Provisions, Contingent Liabilities, and Contingent Assets should be studied and leveraged accordingly for reporting purposes.

Another industry that is the worst hit by this pandemic is real estate. There are lakhs of unsold apartment units across the country. People are unwilling to put their money in a home in these uncertain times. They want to conserve cash. As a result, the property prices have fallen by a big margin. Real estate companies in such situations might want to adjust the carrying value of unsold inventories to their net realizable value in accordance with the principles of IAS 2 – Inventories. Likewise, automobile industries, consumer electronics, capital goods, oil & gas companies might be subjected to an inventory valuation as the goods cutting across the economy remain unsold during the lockdown, and in the near time the demand to remain depleted.

At the start of the new year, I personally didn’t expect the endemic in a local Chinese province to spread to the extent I see it now. Neither did the countries outside China expect that it would hit them so hard. India’s recent fiscal ended on March 31, 2020, and as of the end of that period, many companies didn’t anticipate that the lockdown would be extended by another 15 days. So companies might have to invoke IAS 10 – Events after the reporting period to determine how the subsequent event will be reflected in the financial statements. A classic example here – The company has $100 Mn in its accounts receivable with a provision of doubtful debts of $500k, the company will now have to ascertain and report if the provision has to be increased considering lockdown extensions and more countries subsequently shutting their borders.

Challenging times indeed! Some fortunate souls are getting the privilege of working from home and their paychecks to maintain the status quo, while millions of others in informal workers are out without pay struggling to make their ends meet. I am confident we as a nation will fight this adversity and bounce back with a higher rigor in the days to come.

To my friends in finance, you will have to face two challenges – One is to help your businesses heal faster from the catastrophe and get it back to sprint again. The other is to accurately report the health of the company to its stakeholders.